Financial Planning, Retirement, Economy

An Emergency Fund Provides Many Benefits

10/12/18 8:00 AM

iStock-626627280.jpgLast week we learned that U.S. workers are open to the idea of participating in an employer-sponsored “payroll-deduction rainy day savings program.” That is encouraging considering how ill-prepared so many Americans appear to be for an unexpected financial setback. For example, an earlier Bankrate poll revealed that an alarming 22 percent of surveyed adults doubt that they could live off of their emergency savings for at least three months, and just 29 percent believe that they would be able to cover their typical outlays for a half a year, the minimum buffer that most financial experts recommend having in place. Similarly, a new report from Wells Fargo and Gallup found that only 55 percent of surveyed investors with at least $10,000 in stocks, bonds, or mutual fund holdings could describe themselves as “very well prepared” to deal with an unexpected $5,000 expense.

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Around 8 in 10 investors (83 percent) feel very well prepared to cope with an unforeseen $1,000 outlay, but just a third of respondents could report the same level of confidence about a sudden $10,000 setback. “Very well prepared” in this particular survey presumably means the ability to cover a surprise expense without having to liquidate one’s investment assets, something which would likely be a lot easier to accomplish with an emergency fund in place. Moreover, short-term savings are intended to help people survive a financial hardship without dipping into their long-term savings prior to retirement. This is important because withdrawing money from a 401(k), IRA, or similar account before the age of 59½ can often result in a tax penalty. Exemptions exist but accessing your old-age savings early can still wind up diminishing your compound growth potential (less money to invest/reinvest), and in the case of 401(k) loans also lead to serial borrowing.

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Another asset that emergency funds can help people avoid tapping into is home equity. Indeed, 15 percent of Americans in a separate Bankrate survey said that they believe “keeping up with regular household bills” is a valid excuse for dipping into their home equity. Such sentiment was especially common amongst Millennials, low earners, and the less educated. Surveyed homeowners who earn less than $30K per year, for instance, were more than three times as likely than those earning $75K annually to say that it is “okay to tap into home equity to cover ordinary bills.” Bankrate’s Greg McBride added that “The idea that nearly 1 in 6 American homeowners views ‘keeping up with regular household bills’ as an appropriate reason to borrow from home equity speaks to how far some households are stretched on a monthly basis. This further exemplifies the importance of having an emergency fund, so when the unexpected happens – and it will happen – there is a savings cushion to fall back on.”

 


 

Sources: Bankrate, Gallup, Wells Fargo

Post author: Charles Couch